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Sam Bankman-Fried was a trader on Jane Street Capital’s international ETF desk before he founded one of the best cryptocurrency trading platforms in the market. He decided to build FTX in the midst of searching for a cryptocurrency trading place where it comes from a trader’s perspective. When he found none, he made the bold move to start his own crypto company; hence, their slogan is “Built by Traders, For Traders”.
FTX was created to fulfill every trader’s needs, no matter where you stand. Be it for the professional, experienced traders who watch the crypto market 24/7, or the beginner who wants to try to get their feet wet in the crypto trading market, FTX provides user-friendly and comprehensive features and explanations in their one-stop system.
What problem is the FTX Funding Rate trying to solve?
First, we have to know the difference between Traditional Futures and Perpetual Futures.
The expiration date is the fundamental aspect of Traditional Futures contracts. When a contract ends, the settlement procedure begins. Traditional Futures contracts usually settle once a month or once a quarter. During the settlement period, the contract price converges with the spot price and then all open positions will expire.
Crypto-derivative exchanges like FTX often provide Perpetual Futures contracts, which are structured similarly to Traditional Futures contracts. Perpetual contracts, on the other hand, have a significant advantage.
Traders in Perpetual Futures can stay in the position without an expiration date and do not need to keep track of different delivery months, unlike Traditional Futures. A trader, for example, can keep a short position open indefinitely unless it is liquidated.
Simply speaking, Traditional Futures is a contract that has an expiry date whereas Perpetual Futures do not expire. Furthermore, Traditional futures usually have a broker in between the trading process where he/she will ask you to top up the amount accordingly based on the “margin calls” or margin difference between the contract price and the spot price. Perpetual Futures are handled by you and only you as the trader.
Due to the fact that perpetual futures contracts never settle in the conventional sense, the exchanges require a system to ensure that futures and index prices converge on a regular basis. There’s where the funding rate kicks in.
What is Funding Rate?
Funding rates are periodic payments to long traders, which foresee the market will go up, and short traders, which foresee the market will go down, based on the difference between the perpetual contract market and spot prices.
Hence, depending on where your standpoint is, you either will receive payment or you are the one paying it.
When the funding rate is positive, the perpetual contract’s price is greater than the mark price. This is where the long traders pay for short traders. On the other hand, when the funding rate is negative, it shows that perpetual prices are below the mark price where the short traders pay for long traders.
The image below shows a few of the funding rates from different cryptocurrencies on the FTX website on 16 June 2021 at 1pm.
How FTX Funding Rates Works
Crypto funding rates prevent lasting divergence in the price of both markets. FTX recalculatates the funding rate every hour, 24 times a day.
Whereas quarterly futures expire, perpetual futures have funding payments every hour. Specifically, every hour, FTX measures the 1-hour TWAP of the perpetual future and the 1-hour TWAP of the underlying index:
This is similar to the future expiring once per day. In particular, if you sell a BTC perpetual future that is trading 0.10% above the underlying index all day, then over the course of the next day you will receive a total funding payment of 0.10%.
For example:
You’d like to buy $100,000 for Bitcoin. Then, according to the predicted funding rate shown in the image above at that moment, you would pay the short traders for $0.90 on that particular hour to directly promote to the one who has short-exchange.
100,000* (0.0009%)= $0.90
This funding rate is a very direct and powerful tool to promote the other side of the trading exchange when either the position is in a positive or negative point. In this example, the market needs to balance off the bullish market by promoting the bearish investors.
Funding rates are done on a peer-to-peer basis. Therefore, FTX does not charge any fees from funding rates as they happen directly between traders – by traders, for traders.
How to make money and earn passive income from FTX Funding Rates
One tip to make some “passive income” from FTX funding rates is to buy AND short the exact same amount of the cryptocurrency you put your money on.
This method can balance out the positive and negative funding rates, where technically you do not have the position in that particular cryptocurrency market since it is counterbalanced.
However, your short trading will get paid on an hourly basis. So, you can get some great “passive money” on the side, even though overall it mostly turns out to be net value since you have the positive trades too.
This defunding method is a lot of big trading firms’ favorite method to get quick money in a larger amount.
Conclusion
In the Perpetual Futures market, crypto funding rates are crucial. Most crypto-derivatives exchanges like FTX use a funding rate method to ensure that contract prices are always in line with the index. Market factors dictate these rates, which fluctuate when asset values change bullish or bearish.
Take the advice here with a pinch of salt as every fluctuation in the market is unpredictable and risky.
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